Happy New Year!
Now, Let's Get Down to Business
It's the New Year and with it comes many changes that may affect your financial future. This month seems like a perfect time to make sure you have the right information to enable you to make the most of your money.
The Golden Years
It's an unfortunate fact of life that there are fewer pension plans to provide the average worker with retirement income. That means most of us will have to fund our own retirement and that means saving - a lot! The good news is that the United States Congress has provided us several tax-advantaged ways of putting money away for retirement and, in 2007, most of the limits on your savings will increase.
Elective Salary Deferrals
If your employer sponsors a 403(b) or 401(k) plan, the amount of salary you can defer in 2007 will increase slightly. Assuming you meet the eligibility requirements for your plan, the maximum you can contribute in 2007 will be $15,500 (up from $15,000 in 2006). You can also add an additional $5,000 in ‘catch-up' contributions if you are age 50 or older. Even though these salary deferrals won't escape Social Security and Medicare taxes, you will avoid income tax until you withdraw the funds during your retirement years.
While individuals can only contribute up to $15,500 (or $20,500) in salary, some employers' defined-contribution plans match employee deferrals and/or provide for profit-sharing payments. In these instances, additions to an employee's account can be dramatic. In 2007, the combination of employee and employer contributions to a participant's account under a defined-contribution plan will be $45,000.
If your employer sponsors a SIMPLE IRA plan, the maximum you can defer in 2007 has also increased. That 2007 contribution will be $10,500, a $500 increase from 2006. The allowable ‘catch-up' contribution if you are 50 years of age or older remains at $2,500.
A Defined Contribution Plan is one where an annual contribution is made and the benefits at retirement are based on the account balance. On the other hand, a Defined Benefit pension plan seeks to provide a pre-determined amount of retirement income, regardless of the assets available at retirement. To prevent employers from funding defined benefit plans only to the advantage of highly paid employees, Congress set a limit on benefits under such plans. In 2006, that amount was $175,000 and will increase to $180,000 in 2007.
A second limitation Congress set in place to prevent highly paid employees from abusing retirement plan provisions of the tax code is the amount of income that can be taken into account in determining retirement plan limitations. For 2007, that amount will increase to $225,000 from $220,000 in 2006. To illustrate the importance of this limitation, assume an employer makes a 3% profit-sharing contribution in 2007. In the absence of the limitation, an employee who makes $1 million would receive a contribution of $30,000; however, because of the $225,000 maximum-income rule, the deposit to the employee's account will only be $6,750.
Individual Retirement Accounts
If you are not eligible for an employer sponsored retirement plan, or if you meet certain income limitations, the last line of defense for tax deferred retirement savings is the Individual Retirement Account (IRA). Unfortunately, the limits on the IRA will not increase in 2007. The maximum contribution you will be allowed to make is $4,000 for yourself and possibly an additional $4,000 in a spousal IRA. The law does allow for a $1,000 ‘catch-up' contribution if you are age 50 or over.
Health Savings Accounts
Prior to the enactment of recent law, if you wished to take advantage of a health savings account, the most you could save and deduct for tax purposes was the lesser of the deductible on your high-deductible health plan OR an amount specified by law. In 2007, regardless of the amount of your health plan's deductible, you will be able to add up to $2,850 to your account if you are single and $5,650 if you carry family coverage.
Your ability to defer income is not the only thing that will change in 2007. The social security wage base will increase by $3,300 in 2007 to $97,500. This means the maximum social security tax paid by an employee will increase from $5,840 in 2006 to $6,045 in 2007. If you are self-employed, your maximum tax will be $12,090. Wages on which you will pay Medicare tax remain unlimited.
This article presents just a few of the "increases" in 2007 that will affect your financial planning decisions. Other inflationary adjustments related to standard deductions and tax rates will also take effect. If you are you working on your 2007 financial plan, give us a call and let's make sure you have the right numbers to make the best decisions.
Happy New Year!